What are Quality Costs?
Quality costs are the costs associated with preventing, detecting, and remediating product issues related to quality. Quality costs do not involve simply upgrading the perceived value of a product to a higher standard. Instead, quality involves creating and delivering a product that meets the expectations of a customer. Thus, if a customer spends very little for an automobile, he will not expect leather seats and air conditioning - but he will expect the vehicle to run properly. In this case, quality is considered to be a vehicle that functions, rather than a luxury experience. Quality costs fall into four categories, which are noted below.
Prevention Costs
You incur a prevention cost in order to keep a quality problem from occurring. It is the least expensive type of quality cost, and so is highly recommended. Prevention costs can include proper employee training in assembling products and statistical process control (for spotting processes that are beginning to generate defective goods), as well as a robust product design and supplier certification. A focus on prevention tends to reduce preventable scrap costs, because the scrap never occurs.
Appraisal Costs
As was the case with a prevention cost, an appraisal cost is incurred in order to keep a quality problem from occurring. This is done through a variety of inspections. The least expensive is having production workers inspect both incoming and outgoing parts to and from their workstations, which catches problems faster than other types of inspection. Other appraisal costs include the destruction of goods as part of the testing process, the depreciation of test equipment, and supervision of the testing staff.
Internal Failure Costs
An internal failure cost is incurred when a defective product is produced. This appears in the form of scrapped or reworked goods. The cost of reworking goods is part of this cost.
External Failure Costs
You also incur an external failure cost when a defective product was produced, but now the cost is much more extensive, because it includes the cost of product recalls, warranty claims, field service, and potentially even the legal costs associated with customer lawsuits. It also includes a relatively unquantifiable cost, which is the cost of losing customers.
Where do Quality Costs Occur?
Quality costs can arise anywhere in a company. There may be product design issues that begin in the engineering department, as well as manufacturing problems that can create product flaws. Further, the procurement department may acquire substandard components that result in product flaws. In addition, the order entry department may have incorrectly entered a customer order, so that the customer receives the wrong product. These issues all result in quality costs.
Impact of Quality Costs on Profitability
Quality costs can comprise a major portion of the total expenses of a business, though they are hidden within its normal cost recording system, which is oriented more toward recording by responsibility center than by quality issue. The mitigation of quality issues can greatly increase the profitability of a business, as well as enhance the level of customer retention.
How to Measure Cost of Quality (COQ)
The methods for calculating Cost of Quality vary from company to company. In many cases, organizations like the one described in the previous example, determine the Cost of Quality by calculating total warranty dollars as a percentage of sales. Unfortunately this method is only looking externally at the Cost of Quality and not looking internally. In order to gain a better understanding, a more comprehensive look at all quality costs is required.
The Cost of Quality can be divided into four categories. They include Prevention, Appraisal, Internal Failure and External Failure. Within each of the four categories there are numerous possible sources of cost related to good or poor quality. Some examples of typical sources of Cost of Quality are listed below.
The Cost of Good Quality (CoGQ)
- Prevention Costs – costs incurred from activities intended to keep failures to a minimum. These can include,
but are not limited to, the following:
- Establishing Product Specifications
- Quality Planning
- New Product Development and Testing
- Development of a Quality Management System (QMS)
- Proper Employee Training
- Appraisal Costs – costs incurred to maintain acceptable product quality levels. Appraisal costs can include, but are not limited to, the following:
- Incoming Material Inspections
- Process Controls
- Check Fixtures
- Quality Audits
- Supplier Assessments
The Cost of Poor Quality (CoPQ)
- Internal Failures – costs associated with defects found before the product or service reaches the customer. Internal Failures may include, but are not limited to, the following examples:
- Excessive Scrap
- Product Re-work
- Waste due to poorly designed processes
- Machine breakdown due to improper maintenance
- Costs associated with failure analysis
- External Failures – costs associated with defects found after the customer receives the product or service. External Failures may include, but are not limited to, the following examples:
- Service and Repair Costs
- Warranty Claims
- Customer Complaints
- Product or Material Returns
- Incorrect Sales Orders
- Incomplete BOMs
- Shipping Damage due to Inadequate Packaging
These four categories can now be applied to the original Cost of Quality equation. Our original equation stated that the Cost of Quality is the sum of Cost of Good Quality and Cost of Poor Quality. This is still true however the basic equation can be expanded by applying the categories within both the Cost of Good Quality and the Cost of Poor Quality.
- The Cost of Good Quality is the sum of Prevention Cost and Appraisal Cost (CoGQ = PC + AC)
- The Cost of Poor Quality is the sum of Internal and External Failure Costs (CoPQ = IFC + EFC)
By combining the equations, Cost of Quality can be more accurately defined, as shown in the equation below:
COQ = (PC + AC) + (IFC + EFC)
One important factor to note is that the Cost of Quality equation is nonlinear. Investing in the Cost of Good Quality does not necessarily mean that the overall Cost of Quality will increase. In fact, when the resources are invested in the right areas, the Cost of Quality should decrease. When failures are prevented / detected prior to leaving the facility and reaching the customer, Cost of Poor Quality will be reduced.